Chapter 3: The Ricardian Model with an Endogenous Natural Rate
INTRODUCTION 3.1 In Chapter 1, we made the point that there appear to be two traditions in the treatment (or non-treatment) of unemployment in the international economics literature. On the real side of international economics, full employment is typically assumed though there is a small amount of literature dealing with the eﬀects of minimum wages (see, for example, Brecher, 1974). Eﬃciency wages have also been introduced into a Ricardian economy by Copeland (1989), whose model nevertheless generates an endogenous wage gap among identical workers without generating equilibrium unemployment. On the monetary side of international economics, the prevailing paradigm is that of Keynesian economics applied to the open economy. The result is the Mundell–Fleming model.1 We can rationalise this division by alluding to the classical dichotomy. In the short run – the domain covered by the monetary side of international economics – the price level is somewhat rigid or sticky. Consequently, unemployment, which is viewed from this perspective as cyclical in character, ﬂuctuates in response to various economic shocks. In the long run – the domain covered by the real side of international economics – the price level is completely ﬂexible, and the economy settles at the natural level of employment or unemployment. Thus the theory has explanatory power for improving our understanding of what causes unemployment to deviate from the natural level. However, the economic forces that lead countries to exchange goods and services with one another and that aﬀect the real incomes of factors of production under international exchange...
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